Sebastian Mallaby, one of my favorite columnists, betrays both wisdom and economic sense in yesterday’s column exhorting readers, and Obama, not to give into those that would decry markets as one of the tools to lead us out of this mess. Money quote:

So blaming deregulation for the financial mess is misguided. But it is dangerous, too, because one of the big challenges for the next president will be to defend markets against the inevitable backlash that follows this crisis. Even before finance went haywire, the Doha trade negotiations had collapsed; wage stagnation for middle-class Americans had raised legitimate questions about whom the market system served; and the food-price spike had driven many emerging economies to give up on global agricultural markets as a source of food security. Coming on top of all these challenges, the financial turmoil is bound to intensify skepticism about markets. Framing the mess as the product of deregulation will make the backlash nastier.

The first half of his column makes some technical assertions about trade that I thought I might be able to unravel a bit for Fat Triplet readers. Mallaby states:

The real roots of the crisis lie in a flawed response to China. Starting in the 1990s, the flood of cheap products from China kept global inflation low, allowing central banks to operate relatively loose monetary policies. But the flip side of China’s export surplus was that China had a capital surplus, too. Chinese savings sloshed into asset markets ’round the world, driving up the price of everything from Florida condos to Latin American stocks.

The United States has had a trade deficit with China for many years. This means that we imported more goods from China than we exported to China. Most people know this and it is a cause of alarm to many people (although I am in the camp that thinks that the problem with trade deficits are frequently overstated). But anytime there is a trade deficit it is offset by a “capital surplus”. We buy Chinese goods and those goods are paid for with US Dollars. A country with a trade surplus, such as China, will accumulate the currency of the country with whom they have the trade surplus, in this case the US Dollar. Because those dollars can only be used to buy items denominated in US Dollars, China has used the money to buy assets in the United States. These assets may be things like commercial or non-commercial real estate, corporations, land, etc. Increased demand for these products from foreign investors helped to drive up the price of these assets while helping to keep a lid on the price of consumer products and the overall rate of inflation. Another asset that has been purchased in huge quantities by the Chinese is US Treasury Bills. In other words, the Chinese have been funding the US National Debt. This means is that things are going to get very ugly for the Chinese. Especially, if the Federal Reserve has to fire the bullet of last resort to get the economy going, the printing of money. I think that is a distinct possibility at this point.

Steve